Salomon: U.S. leads decline in E&P spending

Worldwide exploration and production expenditures are in the most severe contraction since 1986, says Salomon Smith Barney, New York.

According to the firm's annual survey of upstream spending, global E&P outlays will decline by 11% in 1999 from 1998's level.

"This will be...only the second time in the 38 years for which we have reliable data that spending will decline by over 10% from the prior year," said the analyst. "It will also mark the reversal of 6 years of growth in demand for the oil industry. Furthermore, the tone of our discussions with 175 E&P companies reflects the most tentative and uncertain sentiment in the industry for at least a decade."

How 1998 spending changed

Macroeconomic factors depressed global oil demand last year, contributing to the lowest oil prices, in real terms, in 25 years, says Salomon. This drove the petroleum industry to make severe midyear corrections in spending in 1998.

Although, at the time of last year's survey, growth of 8.4% was projected for U.S. upstream spending in 1998, Salomon estimates 1998 outlays dropped 0.2% vs. 1997 (OGJ, Mar. 23, 1998, p. 46).

In Canada, the 1998 survey indicated that spending would rise by 6.7% in 1998. Based on late-year data, however, 1998 upstream outlays there are now expected to be 18.5% less than in 1997.

Spending in 1998 outside the U.S. and Canada was 13.5% greater than for the previous year, in contrast with the 14.4% increase projected 1 year ago.

"Very few in the industry anticipated that we would see WTI price fall below $11 in 1998, and our respondents are clearly reluctant to plan on a quick reversal," said Salomon Smith Barney.

"The unexpectedly sharp decline and persistent oil price weakness have caused a dislocation in exploration and development programs that began in the latter half of 1998. One of the results of this dislocation is the wave of consolidation that is taking place in the E&P industry, including Exxon Mobil, British Petroleum-Amoco, Kerr-McGee-Oryx, Ocean Energy-Seagull, and as yet unannounced combinations (see related story, p. 38)."

Survey results for 1999

Salomon surveyed 175 E&P companies to assess their upstream spending plans for 1999. The data do not include spending for acquisitions, says Salomon, which has adjusted its reporting to reflect the effects of acquisitions that occurred during the past year.

According to the results of the most recent survey, the U.S. will show the largest decline in upstream spending, with a decrease of 20.9%. Activity in Canada is expected to decline 3.6%, and spending outside the U.S. and Canada is projected to decline 6.9%.

The declines contrast sharply with the increases expected 1 year ago. At that time, spending increases for 1998 were projected to be 6.1% in the U.S., 6.7% in Canada, and 14.4% elsewhere.

The 175 firms surveyed this year plan total global E&P expenditures of $79.2 billion in 1999 vs. $89.0 billion in 1998. Of total spending, 28% will be on projects in the U.S., 9% in Canada, and 63% outside of those two countries.

The surveyed companies' 1999 spending plans are based on an average WTI price assumption of $14.67/ bbl, down by more than $4/bbl vs. 1998 plans.

For the companies in Salomon's survey, E&P expenditures outside the U.S. and Canada are expected to total $49.8 billion for 1999 vs. $53.6 billion last year (see top table, p. 53).

"The (spending) plan for 1999 marks the end of 4 straight years of double-digit growth in spending outside (the U.S. and Canada)," said Salomon, "suggesting that surplus capacity issues thatellipseplagued (U.S. and Canadian) oil markets in 1998 are set to spread overseas."

In Canada, upstream outlays are projected to decline to $7.3 billion in 1999 from $7.6 billion in 1998 (see bottom table, p. 53).

"(The) dramatic decline in (Canadian spending for) 1998 we believe is the principal reason that spending reductions planned for 1999 are so modest," said Salomon Smith Barney. "In addition, increased spending offshore the East Coast of Canada, driven by project timing, is masking more severe declines in traditional sectors."

In the U.S., E&P spending is expected to total $22.1 billion this year, a decline from $27.9 billion in 1998 (see table, this page).

Spending by the 111 independent firms surveyed is expected to decline to $10.3 billion from $13.4 billion in 1998, a fall of 22.8%. The 15 major oil companies with significant U.S. activity are expecting a 19.1% decrease in U.S. spending this year, to $11.7 billion from $14.5 billion in 1998.

"Despite the large reduction in expected U.S. spending, the Gulf of Mexico is still far and away considered the area of greatest exploration potential, while regions that are experiencing financial instability, such as Asia-Pacific and the former Soviet Union, lost significant standing in this category," said the analyst.

Key trends

Salomon Smith Barney noted several important observations based on responses to its survey. Among these are:

Expenditure reductions are surprisingly balanced between exploration and development.
Cash flow and commodity prices have displaced attractive drilling prospects as the most important determinants of spending.
Spending plans for 1999 are significantly more sensitive to changes in oil and gas prices than in previous years.

The firm says it should come as no surprise to anyone that spending will be down in 1999, or that it will be "an historically large contraction."

Salomon also expects continued industry consolidation to further soften demand for oil services. "The (survey) results reinforce our view that 1999 will be one of the most difficult for oil service companies in recent memory."